Carry trade strategies across G10 and emerging market currencies have delivered strong paper gains in recent months, but analysts warn these returns rest on fragile foundations shaped by geopolitical tensions and elevated interest rates rather than structural advantages.
G10 carry gains driven by currency volatility
Commerzbank analyst Michael Pfister said G10-based carry strategies outperformed pure interest income in the first quarter, mainly because currency swings moved in favor of existing positions.
He stressed that the improvement did not reflect any inherent edge in the strategy. Instead, much of the outperformance came during bouts of exchange rate volatility linked to developments in Iran and broader geopolitical uncertainty.
Despite the recent success, Pfister said there is no statistical evidence that carry trade strategies consistently outperform over the long term.
Emerging market carry lifted by high yields
Carry trades in emerging markets have also gained traction, supported by strong performances from high-yield currencies such as the Brazilian real and Mexican peso.
The Bloomberg Emerging Markets Carry Trade Index has posted solid gains since early 2025, largely driven by elevated interest income. Exchange rates in many of these currencies are still recovering from declines recorded in 2024, leaving the currency component of returns uneven.
According to Pfister, emerging market carry trades benefit when exchange rate moves line up with yield differentials, but their sustainability depends on external conditions, not on any built-in advantage. Recent performance, he said, remains primarily a function of high interest income rather than lasting capital appreciation.
Strong 2025 sets the stage for 2026
The latest gains follow an exceptionally strong 2025. One widely watched gauge of emerging market carry strategies returned around 18% that year, its best performance since 2009.
Momentum continued into early 2026. A Bloomberg index tracking eight developing-market currencies rose 1.3% by late January, reflecting optimism that tight monetary policy and credible central banks in several countries would keep yields attractive.
Analysts at firms including Morgan Stanley and Bank of America had expected these returns to extend through 2026. James Lord, for example, highlighted the Brazilian real, Turkish lira and Czech koruna as preferred currencies for carry strategies at the start of the year.
Conflict-driven volatility reshapes the outlook
That backdrop has shifted sharply since late February, when a military conflict involving the United States and Iran began. Market moves in March were dominated by this escalation, which has now become the key theme for currency markets.
In its April 2026 report, the International Monetary Fund warned that heightened geopolitical risks in the Middle East could test the resilience of the global financial system. The IMF cautioned that in emerging markets, abrupt unwinds of carry trades risk amplifying currency pressures if turmoil intensifies.
The core carry strategy—borrowing in low-yielding currencies to fund positions in higher-yielding ones—is directly challenged by this new environment. Rising volatility tends to work against positions built on relatively stable interest rate differentials.
Paper profits at risk from sudden reversals
For those active in these markets, the same conditions that helped generate recent paper gains—conflict-driven exchange rate moves—are now the main source of instability.
Pfister noted that carry trades tend to perform best when geopolitical or macroeconomic shifts create temporary return imbalances between markets. But he added that other approaches may offer more reliable outcomes when currency adjustments swing against carry positions.
A sudden reversal in sentiment could quickly erode gains as traders rush to reduce risk, dumping higher-beta assets and rotating into traditional safe-haven currencies.
Focus on US–Iran ceasefire and policy outlook
Attention in the near term is centered on geopolitical developments in the Middle East. The ceasefire between the US and Iran is due to expire on April 22, and any failure to extend the truce could spark sharp and unpredictable market moves.
Such a scenario would likely trigger a rapid unwinding of carry positions, with outsized effects in higher-yielding emerging market currencies.
Domestic risks in high-yield markets
Beyond the immediate conflict, domestic vulnerabilities in key high-yield economies remain in focus.
Brazil and Mexico face election uncertainty and fiscal pressures that are expected to shape their economic paths this year. While the Mexican peso delivered a strong performance in 2025, it is now forecast to weaken as trade uncertainty grows and remittance flows soften.
These underlying risks add another layer of fragility to carry trade performance, reinforcing concerns that the recent run of strong paper gains may prove difficult to sustain if conditions turn.
To master this strategy, explore how carry trading works and how volatility shapes your potential returns.
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